The Real Risk of the Chinese Economy
Though I rarely respond to other bloggers, ever so often I read something that causes me so much heartburn, I am forced to respond. Marginal Revolution posted a link to the blog Synthenomics criticizing people like myself who are shall we say, rather concerned about the Chinese economy.
Lulu Wang accurately addresses the issue many Chinese face with a lack of investment options and choosing to invest in housing but stumbles writing “The real risk is not that the housing won’t be used, but that the crash would have secondary effects.” Let’s state this clearly: the real risk is that the housing, industrial capacity, or solar generation won’t be used. Every other risk is political and comes from that risk.
Let’s examine this a bit further. In the past 5-8 years, and especially the past 3, China has built an enormous amount of stuff that nobody wants, needs, or uses. Fueled by a lending boom that began in late 2008 and tripled total lending in 2009, Chinese government at all levels has been spending money like a drunken sailor on leave. What should scare people however, is just how poorly this money has been spent. To give you a few examples:
- The Beijing government admits that 50% of apartments sit empty. A similar number is found in most major cities in China, not to mention the entire cities that sit empty.
- After major investment in wind power generation, most wind power capacity was incapable of generating power because…..it was not hooked up to the grid.
- Housing price to income ratios that would make a California real estate bubble blush. The average home price to income ratio peaked around 12 in California. The China Daily (the Communist party mouth piece) speaks regularly of ratios in excess of 25. One recent article noted that the average price per square foot in Beijing was nearly $300 while monthly per capita GDP was only $435. That means using the long term global average for the income to housing price ratio, the average Beijinger should be able to buy a 91 square foot apartment.
- Industrial capacity utilization that is officially at 60%. (If you believe the official numbers I have a 91 square foot apartment I’d like to sell you) This is driven by state owned banks and enterprises that over invested in 2009 due to the stimulus fueled lending boom.
To say that “the real risk is not that housing (or any other similar asset) won’t be used is simply non-sense. This government fueled spending binge comes from the backs of the Chinese. When Scott Sumner asks “what do you want them to build more of?” and Lulu responds “that Scott can get a haircut for $4 or an ice cream cone for 50 cents shows how low productivity and wages are in China” demonstrates how far removed from reality both are.
Despite protestations to the contrary, the Chinese are purposefully suppressing consumption to pay for their white elephants. With corporate tax rates of 65% and a total personal rate of about 70%, it should come as no surprise that consumption in China represents such as small fraction of the economy. Living in China I can attest first hand to the fact that China has easily the highest price level of any country I have visited in the past two years. An ice cream cone for 50 cents? Lulu obviously has spent too much time in Michigan and not in China. Without the willful suppression of the Chinese consumption to pay for political boondoggles in the form of forced public savings, who would pay for trips to Macau?
What Lulu Wang does allude to but misses its importance, is the political economic drivers. For instance, he writes: “I want them to start building leaf blowers, so we don’t have so many Chinese people in the low productivity position of sweeping streets.”
Let’s make the political economic driver as crystal clear as possible: the Chinese government has made a very clear and conscious decision to create low productivity jobs in order to prevent civil unrest. Beijing isn’t concerned about the 2/3 of the population that still live as subsistence farmers in rural areas. Farmers in rural areas can’t riot in Tiananmen Square. City dwellers in Shanghai and Beijing that don’t see a new mall being built can cause problems. As long as people are working, even if it is doing things incredibly inefficiently and building bridges that collapse, at least they aren’t rioting in the streets. The unemployed riot, while those working and enjoying Party beneficence do not. The Chinese government has no interest in creating high productivity workers that efficiently build businesses because that removes the political control. The MIT economist Yasheng Huang has estimated that still around 80% of the Chinese economy remains in state hands. There is no Chinese economic liberalization story. It is all a party control story.
Now to the scary part. The Party is scared. Every 10 years there is a power hand over. There will be a power hand over later this year. Every incoming leader is petrified of being the leader under whom China collapses. There is typically a political crackdown and economic goodies all around.
However, this year has not been a good year for the party. Economic data that is now just blatantly made up, at least one coup attempt to begin the year, and a collapsing economy do not make ideal conditions to hand over power.
Outsiders do not realize how tense things are in China right now and bad business is. In my local mall where police used to stroll by, large battalions of police troops are now regular guests. Small tanks and rows of paddy wagons line the street under the Starbucks every night.
Beijing has backed themselves into a corner and the downside risk is this: announce the apartment owners that their homes are now worth 50% less. Then see what happens in Tiananmen Square.